No doubt Fed will hike rates in June

But some question the wisdom of tightening further

WASHINGTON (MarketWatch) -- Scientists tell us that one sign of intellegence is a capacity to step back and reassess your surroundings after you're hit in the head with a stick.

So it is with Wall Street economists, who, after entertaining the notion that the Fed might pause at the end of the month, have abandoned the notion after several well-placed whacks in the form of hawkish rhetoric from Fed officials.

'We have to respect what the Fed is signaling to us. They are telling us in no uncertain terms that they are prepared to raise rates.'
David Rosenberg, Merrill Lynch

Now, less than two weeks before the June 28-29 meeting of the Federal Open Market Committee, economists and the financial markets are in agreement that the Fed will raise its short-term rate target to 5.25% following two days of policy deliberation.

A fair amount of muttering has recently been heard from economists who believe it might be prudent for the central bank to pause and assess whether the scattered signs of an economic slowdown gather force.

Although some economists question the wisdom and providence of the "relentlessly hawkish" rhetoric, no one doubts its intent over the past few weeks. Economists believe the Fed adopted a hawkish tone out of concern that the market was questioning the central bankers' inflation-fighting credibility.

"They turned more hawkish, and they turned to focus on the near-term inflation indicators instead of focusing on the longer-term inflationary outlook over the next 18 months," said Richard Berner, chief economist at Morgan Stanley Dean Witter.

Earlier this month, economists were describing a dilemma for a central bank seeking to chart a course amid signs of both rising inflation and a softening economy. But in a June 5 speech, Fed chief Ben Bernanke came down squarely in the camp of those who see inflation as a bigger threat.

Bernanke highlighted elevated three-month and six-month rises in core inflation as being "at or above" the upper range that he would find acceptable, and called it an "unwelcome development." See full story.

In the same speech, Bernanke seemed to welcome signs of a slowdown, saying that the economy was running out of slack at its previous rate of growth.

With Bernanke and other Fed officials saying inflation is at the high end of their comfort zones, "the market has reasonably gone to the view that they are going to go a quarter-point" in June, and also worry about the prospect of another move later in the summer, said James Glassman, economist at J.P. Morgan Chase.

Before Bernanke spoke, a soft May employment report had financial markets thinking there was an even chance the Fed would pause in June.

"We have to respect what the Fed is signaling to us," said economist David Rosenberg of Merrill Lynch. "They are telling us in no uncertain terms that they are prepared to raise rates."

"The Fed's attitute is undeniable, even if possibly questionable," said Maury Harris, economist at UBS Securities.

Roger Kubarych, economist at HVB Group, said the Fed is moving interest rates into "restrictive territory," which carries significant risks for the economy.

An overshooting on rates "is capable of transforming a mild deceleration into a more serious slowdown -- as it did in 2000," he said.

Any remaining doubts of a Fed hike were erased after the May consumer-prices report showed that core inflation had increased 0.3% for a third straight month. See full story.

Dean Maki suggested the Fed might consider pushing the federal-funds rate to 5.5% in June, but others said a half-percentage rate hike would break with the norm and smack of panic.

Most economists said Bernanke will use his semiannual Humphrey-Hawkins testimony before Congress to guide markets about the future course of interest rates.

But, at the moment, economists and the market are expecting another quarter-point increase at the Aug. 8 meeting.

Greg
Robb

Greg Robb is a senior reporter for MarketWatch in Washington. Follow him on Twitter @grobb2000.

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